What to be aware of about guarantees?

The English Courts held in 2011 and 2012 celebrated decisions about independent guarantees that, in our view, clearly define it. This article aims to summarise the Court’s understanding of the issue. The cases that are being commented on here are the following: (1)?Meritz Fire & Marine Insurance Co Ltd v Jan de Nul NV?[2011] EWCA Civ 827 (21 July 2011); (29 July 2011); (2)?Wuhan Guoyu Logistics Group Co Ltd, Yangzhou Guoyu Shipbuilding Co Ltd v Emporiki Bank of Greece SA?[2012] EWCA Civ 1629 (7 December 2012).?

It is worth mentioning that the English Courts recognised the nature of performance guarantees (or on-demand bonds) in a series of cases in the late 1970s. The most important was?Edward Owen Engineering Ltd v. Barclays Bank International Ltd?[1978] Q.B. 159[1]. In this case, it can be affirmed that the Courts drafted the critical elements of a demand guarantee and differentiated them from those of a traditional warranty.?

For further reading, another two cases are indispensable:?Marubeni?Hong Kong and South China Ltd v. The Mongolian Government[2]?and?Vossloh Aktiengesellschaft v. Alpha Trains (UK) Ltd[3]. They are also references for the differentiation between independent and traditional guarantees and their implications.?

The underlined context is of an instrument of a warrant which presents conflicting elements that impede its definition on first reading or impression. The contradictory elements within an instrument of the guarantee built the phenomenon held and defined by the Courts, which is now explained in this Article.?

1. Meritz Fire & Marine Insurance Co Ltd v Jan De Nul NV (21 July 2011):

On 21 July 2011, the Court of Appeal dismissed the appeal in?Meritz Fire & Marine Insurance Co Ltd v Jan de Nul.?It confirmed that an instrument of guarantee, “advance payment guarantee”, issued by a bank was a performance bond or demand guarantee instead of contracts of suretyship. This case deems to stand at the starting line of cases where a new solution about the differentiation between types of guarantee has arisen. Although they were subjected to Uniform Rules for Demand Guarantee (URDG), the description of the instrument appointed it to be a traditional guarantee. The appeal, which received a great deal of business people’s attention, dealt with the substance of those instruments to confirm first whether the instruments were independent guarantees and after to decide whether the guarantees had been terminated or not in light of modifications that had occurred in the cases’ underlying relations.?

The submission of the guarantees to the rulings of URDG was one of the factors deemed to contribute substantially to the result of the decision. It might be clear that when the parties agree to include the URDG into the instrument of guarantee, they are declaring their intention in the way of construing a demand guarantee and not a traditional guarantee, and that the declaration might prevail.?

The commented decision provides a considerable commercial impact because it deems to provide security for those dealing with instruments of guarantee[4], which are subjected to the URDG. In its turn, this section is concerned mainly with the impact of the inclusion of URDG in the confused instrument of guarantee and its legal implication.

1.1. THE DECISION:

The facts of the case are the following.?Meritz Fire and Marine Insurance Co?Ltd have issued two advance payment guarantees in favour of the defendants,?Jan de Nul NV?and?Codralux, guaranteeing the repayment of payments made by the defendants as buyers under three shipbuilding contracts. The guarantees were entitled “advance payment guarantees” and were submitted to the Uniform Rules for Demand Guarantee (URDG). The applicant for the warrants was a Korean shipyard, Huen Woo Steel Co ltd (“HWS”). The guarantees were issued under shipbuilding contracts. The corporate identity of the shipbuilder had changed between the issuance of the guarantees and its demand. Further, the successor company entered liquidation due to bankruptcy.?

There was a default in the underlying contractual obligation[5]. The claimants called on the guarantee. The insurance company argued that the instrument of warranties was made under a secondary undertaking to pay. The guarantor was discharged from its obligation to repay because there were material variations in the underlying shipbuilding contracts, especially the changes in the corporate identity of the principal shipbuilder and further the liquidation of the successor company, that under the traditional doctrine of guarantee was sufficient to dismantle the obligation. Not spontaneously honoured, the defendants sought proceeds against the Appellant to enforce payment of the guarantees. The Commercial Court gave the defendants a favourable decision to implement the guarantees’ demand and provide payment in their favour[6]. The insurance company appealed. The appeal was dismissed on the following grounds.?

The preliminary question addressed to the Court of Appeal was whether the instrument of guarantee in the analysis was a variation of the traditional guarantee, as suggested by its name, or whether it was a “performance bond or on-demand guarantee”[7].?

Secondly, it was discussed whether the modifications to the underlying contract’s relation could affect the guarantee (terminate them).

The Court of Appeal upheld that although the instruments were named (advance payment) “guarantee”, elements favoured its consideration as the primary guarantor’s undertakings to pay. Among the factors, the Court of Appeal considered the inclusion of URDG as an element which built the guarantee. The legal impact of that consideration was the application of the principles of demand guarantee provided in that rule. Thus, the changes in the applicant's identity or the changes that occurred in the underlying relation (including the termination of the contracts) were held not to affect the guarantor’s obligation to honour the guarantees[8]. Therefore, the insurance company was obliged to pay the defendant the amount provided in the guarantees.??

1.2. ANALYSIS:

1.2.1. The Presumption:

The matter of presumption deems revealing for defining the nature of a guarantee. The analysis of the inclusion of URDG relates to some extent to that matter. In the?Marubeni Hong Kong and South China Ltd v. Mongolia[9], it was established that there was a presumption in favour of considering the instrument of guarantee as a traditional guarantee when non-banking institutions issued it[10]. For those institutions to provide an independent guarantee, they should draft their special intention in their instrument.

The Court considered this presumption (but not applied) in the instant case because Meritz Fire, an insurance company (a non-banking institution), issued the guarantee instruments.?

It was a trend to consider traditional guarantees instead of independent ones. However, the inclusion of the URDG contributed to this scenario, reversing the existing presumption and not applying the rulings established in?Marubeni v. Mongolia?case to the?Mertz Fire?case. The following lines will analyse the inclusion of URDG in the guarantee and specifically to what extent the Court considered the inclusion of URDG.?

According to Lord J Longmore, it can be seen that the intention of the parties who incorporate the URDG into their guarantees is that payment is to be made against the document without reference to the underlying contract between the Principal and the Beneficiary[11].?

The courts’ statements were not as far as much to arguing that a presumption was established to consider the inclusion of URDG as a dominant element among others contained in the instrument. The Courts have not yet referred to this situation as a presumption. However, the inclusion of the rules was contextualised and given substantial importance by the Court of Appeal in light of defining the nature of the guarantee.?

Perhaps a presumption was not officially established in favour of the inclusion of URDG in confused instruments of guarantee might be due to two circumstances[12]. First, it might be because other elements in the guarantee must be weighed. Secondly, it might be due to the illogical imposition against a previous presumption defined over the character of non-banking institutions (Marubeni’s?presumption). In a way, the interpretation trend was considering the guarantee as a traditional guarantee because the issuer was a non-banking institution. The inclusion of the URDG was considered an element against that presumption and not a (contrary) presumption itself.?

Those are conjectures over the Court’s reasoning. The inference that can be made from the Court of Appeal’s understanding is that the case-by-case analysis was to be considered vital for defining the nature of the matter[13]. Other elements such as the terms and conditions of the guarantee and its language might impose to the Court sufficient wariness for not establishing a standard of presumption in considering the inclusion of URDG as a highly valued element of the guarantee’s nature. This understanding is consistent with previous decisions. In the?Marubeni?case, for instance, the Court of Appeal held that the description of the instrument was not conclusive. The Lordships considered that the instrument’s language plus the relevant contract provision constitutes the “wording of the instrument”[14].

Although the Courts had not established a presumption for the inclusion of UDRG, the judgment in Meritz Fire was an opportunity to consolidate the purpose of that rules. This believes that it would have been possible to be established by the Courts a presumption on the inclusion of URDG whether its inclusion was weighed as a dominant element among the others contained in the instrument of guarantee and prevailing on Marubeni’s presumption that instrument of guarantees issued by a non-banking institution tends to be traditional guarantees.?

One effect of this approach would be to include URDG’s more significant value than other (conflicting) elements in the contract, such as the description of the guarantee. The definition of the nature of the instrument would be readily determinable. This probably would provide the commercial community with greater security in the matter. Once the instrument contains a URDG clause, it would be considered a demand bond rather than a guarantee unless substantially proven to have been produced; otherwise, Customers and related third parties probably would find it easier to identify its nature. In addition, the problem about the name of the guarantee would be undermined (almost solved)[15].??

2. Wuhan Guoyu Logistics Group Co Ltd, Yangzhou Guoyu Shipbuilding Co Ltd v Emporiki Bank of Greece SA [2012] EWCA Civ 1629 (7 December 2012)[16]

On 7 December 2012, the Court of Appeal overturned the decision of the Commercial Court in?Wuhan Guoyu Logistics Group Co Ltd v. Emporiki Bank of Greece SA[17]?that considered instruments of guarantee named “payment guarantee” as a contract of suretyship. The law’s impact addresses a peculiar conflicting circumstance: There are instruments of guarantees issued by banks that contain more elements, suggesting it to be a traditional guarantee than an on-demand bond. It called the Court’s attention to weighing the substance of those elements in light of the conclusion about the nature of the guarantee[18]. It can be considered that the instant decision construed decisive guidelines for tackling contends that might appear in confused instruments of guarantees. The Court established a concept, or better referred to, a test to be considered in such circumstances. This test was named “Paget’s presumption”[19].

2.1. THE DECISION

In?The Wuhan Guoyu?case, the matter of the harmony of the elements of the guarantee, such as description, language and terms plus conditions of the instrument, was subjected to analysis. This case concerned a document called a ‘Payment Guarantee’ issued by the Buyer’s Bank to ‘guarantee’ the payment by the Buyer of the second instalment of the price of the vessel. The Buyer infringed the underlying contract and not honoured the second instalment of the cost of Costessey.?

There was a dispute under the underlying agreement about the second instalment payment. Conversely, the seller argued that the guarantees became due.?

The buyer’s Bank argued that the guarantee instrument issued in favour of the seller was a guarantee. Since the buyer disputed its liability to pay the second instalment under the shipbuilding contract, payment was not due under the guarantee Seller argued that, while called a guarantee, the document was like an on-demand bond and that its price was due upon written demand, whether or not the payment, which the bond guaranteed, was actually due by the buyer.?

The nature of the document was subjected to doubt. Unlike the case commented in the previous section, conversely, in the instant case, there were more elements in the instruments suggesting it to be a traditional guarantee than a demand guarantee (bond).?

Whether the instrument of guarantee was of the nature of a traditional contract or on-demand bond was addressed to a particular aspect of differentiation: the interpretation of the “wordings” of the instruments of guarantee[20].?

For considering that matter and answering questions in light of defining the nature of the instrument of guarantee, the Courts, which were involved in this judgment, entered into a discussion for weighing the conflicting elements contained in the instrument of guarantee. For that purpose, the Courts considered the language of the guarantee, the description of the instrument, terms and conditions, and its submission to the URDG.

On 22 June 2012, the commercial court held that the guarantee instruments were traditional guarantees instead of an on-demand bond. Mr Clark J[21]?was convinced that the core obligation in the first clause was one of (standard) guarantees. However, the guarantee instrument included a provision to pay ‘on first written demand’ and an undertaking ‘as primary obligor and not as surety[22].?

The first clause stated that the Bank guaranteed the due and punctual payment of the second instalment by the Buyer. It was a lengthy and complex decision, which probably shows the complicated effort was disposed upon it. Nonetheless, the decision was deemed (by the Court of Appeal) not to have followed previous judgements on the matter.

On 7 December 2012, the Court of Appeal reversed the Lower Court's decision despite recognising that complexities were probably involved. The Court of Appeal held that the instruments were on-demand bonds. Lord J Longmore stated clearly that something “went wrong”, referring to the reversed decision. Longmore LJ in the Court of Appeal summarised that there were ‘6 pointers’ in favour of it being a guarantee and ‘4 pointers’ in favour of it being an on-demand bond. The pointers are extensive[23].?

The method used by Lord J Longmore in the decision of the Court of Appeal for weighing the elements of the instrument of guarantee considering its nature was the application of the ‘Paget’s presumption’, which in turn is a concept provided by Paget’s Law of Banking book[24]. Previous decisions were applied.?

a)??The pointer in favour of or against??

The pointers in favour of and against the consideration of the guarantees as demand guarantees are of easy access in the official transcript of the Court of Appeal decision.?

As part of the method, it is vital to highlight that Longmore LJ understood that although the numbers were appointing to the recognition of traditional guarantee (6 vs 4), the quantity was not (the most) essential matter decide the nature of the guarantee. Longmore, LJ was evident when it stated that it would be ‘absurd’ to determine the issue based on the number of pointers. The nature of the guarantee should be defined by the substance rather than by the number of pointers.??

b) The primary undertaking

The Court of Appeal held in the present case that?Emporiki Bank of Greece SA?was liable to pay to the beneficiary (seller) due to the occurrence of good demand on the guarantees. The obligation to pay (“repay”) was based on the principle of autonomy and strict compliance[25].?

2.2. ANALYSIS:?

2.2.1. Preliminary notes:?

There was a previous presumption in favour of considering the nature of the (confused) instrument of guarantee as a traditional guarantee when the issuer is a non-banking institution. Lord J Longmore felt this principle by reference to the?Marubeni Hong Kong and South China Ltd v. Mongolia[26]?case.?

This presumption did not apply to the instant case of?Wuhan Guoyu v. Emporiki Bank of Greece[27]?because the issuer is a bank[28]. Nonetheless, it can be argued that a specific presumption was created in?Wuhan Guoyu v. Emporiki?Bank to cover its situation.

2.2.2. The Paget’s Presumption:

The rule of presumption considered by the Court of Appeal is based on Paget’s Law of Banking book concept of demand guarantee. According to Paget’s book[29], a guarantee to be considered an on-demand guarantee shall be:?

- First, related to an underlying transaction between the parties in a different jurisdiction.?

- Secondly, be issued by a bank;?

- - Thirdly, contains an undertaking to pay ‘on demand’;?

- Fourthly, not have clauses excluding or limiting the defences available to a guarantor.

Lord J Longmore understood that if an instrument of guarantee contains the elements described in the “Paget’s Presumption” for an on-demand guarantee, it is highly suggested that the instrument be considered[30]. He added that it should even apply when the security document does not contain clauses excluding or limiting the defences available to a guarantor.

Based on Paget’s presumption, the Court of Appeal understood that the wording of the bond itself is instructive of its nature, and its description is not decisive. L J Longmore stated, “… everything must depend on the words used by the parties”[31]. The interpretation of the guarantee’s wording is vital for weighing the elements contained in the instrument to conclude upon the prevailing nature. The presumption created is favourable to that process of recognition in a way that it defines if the wordings of the instrument fulfil the requirements of a demand bond.?

According to commentators’ opinions[32], the Bank's independent guarantee shall be an irrevocable undertaking to pay, independently from the underlying contract, where the issuers undertake a primary obligation to honour it[33]. The arrangement of guarantees in the instant case provided those features.?

According to the “4 (four) pointers” against “6 (six)” enrolled by Lord J Longmore in favour of considering it as a demand guarantee, the instruments contained that: payment by the Bank was to be made on the Seller’s ‘first written demand’, stating that the Buyer had been in default of its payment obligation for 20 days; payment was to be made ‘immediately’ without requiring the Seller to take action against the Buyer; clause 7 stated that the Bank’s obligations were not to be affected by any dispute between the Seller and Buyer under the shipbuilding contract nor by any delay in the construction or delivery of the vessel, and there was a defined limit on the amount covered by the guarantee. These provisions fulfil the presumption established in the Wuhan Guyou case and the concept given by commentators’ opinions.?

The legal impact of the decision studied above was the establishment of a concise guideline (Paget’s presumption) for determining the prevailing nature of guarantee in (confused) instruments. It is crucial to mention that the?Wuhan Guyou?judgment might also impact the commercial aspect of bank guarantees.?

From the commercial point of view, the Bank and other financial institutions shall be more comfortable in drafting and interpreting guarantees instruments because they can rely on an authoritative guide (Paget’s concept of demand bond) for defining their commercial and legal intentions upon drafting instruments of guarantee. From the customer’s point of view, he can look directly at the guarantee instrument to see if the requirements settled in the presumption are present in the instrument.?

2.3. SUGGESTIONS:?

The analysis of those cases involved the nature of the guarantee instrument and its elements. If what is required in an on-demand bond is the presence of those elements mentioned in the above analysis, it could be suggested to the commercial community to undermine the confusion in drafting an instrument of demand guarantee, the following considerations[34].?

First, call it a bond; secondly, call the issuer a bondsman (and not a surety); thirdly, make it clear that the core obligation is a primary obligation to pay on the first written demand; fourthly, include a conclusive evidence clause; and lastly do not include the limitation of liability clauses commonly contained in a traditional guarantee.

3) CONCLUSION:?

This article identified and commented on the most significant recent cases on bank guarantee (demand bonds) and performance bonds decided in the United Kingdom from January 2011 until the date of the submission of this work. It references previous judgements about those instruments and other recent decisions, which are essential to understanding those independent guarantees.?

As the second part of the proposed work, this Article presented the potential impacts that both judgements might have produced in the law of independent guarantees. In the?Meritz Fire?case, where a non-banking institution issued the instruments of guarantee, the submission of the instrument to that rule might undermine the possible doubt upon the guarantee’s nature.?

It was identified that the Court of Appeal considered the inclusion of the URDG as an indication in light of defining the heart of the guarantees as independent guarantees. The future implications of that judgement might be positive in favour of those dealing with bank guarantees, which are subjected to URDG because it provides more security.?

In favour of the decision, this paper's comments were supported by commentators’ opinions; in the?Wuhan Guoyu v. Emporiki Bank of Greece SA?case, where a bank-issued the guarantee instruments, the decision settled authoritative guidelines for determining the nature of the guarantee.?

It was identified that the Court of Appeal considered that the “wording of the instrument” is vital for defining the guarantee’s nature. Even though there were more “pointers” suggesting the traditional guarantee’s nature, the substance of the instrument deems matter most.?

A method was established for determining the nature of the guarantee in the context: the “Paget’s presumption”. If instruments of guarantee issued by banks fulfil the presumption requirements, they are to be treated as independent guarantees unless substantial evidence suggests otherwise. In addition, the description of the instrument was deemed not decisive. This Article provided comments on the Court’s judgment favouring its understandings, supported by previous decisions and commentators’ opinions.?

Those two cases relate to the matter of language of the guarantee. It was suggested that the law should provide more weight to the inclusion of URDG in the instrument of guarantee to determine the nature of the (confused) instrument of guarantee. At least, and additionally, the commercial impact was highlighted, and suggestions were provided to facilitate the identification of instruments of guarantee for future issuances.??

4) BIBLIOGRAPHY:?

I – Primary sources

I (A) Cases?

AES-3c Maritza East 1 Eood v. Crédit Agricole Corporate and Investment Bank [2011] EWHC 123 (TCC) (31 January 2011);?

Comdata Network, Inc. v. First Interstate Bank 497 N.W. 2d 807 (Iowa 1993)

Comdel Commodities Ltd v. Siporex Trade SA [1997] 1 Lloyd’s Rep 424.?

Edward Owen Engineering Ltd v. Barclays Bank International Ltd [1978] Q.B. 159

Enka Insaat Ve Sanayi AS v. Banca Popolare Dell’ Alto Adige SpA [2009] EWHC 2410 (Comm) (6 October 2009);?

Esal (Commodities) Ltd and Reltor Ltd v. Oriental Credit Ltd and Well Fargo Bank NA [1985] 2 Lloyd’s Rep 546, CA.?

Gold Coast Ltd v. Caja de Ahorros del Mediterraneo [2001] EWCA Civ 1086 Lloyd’s Rep.?

Marubeni Hong Kong and South China Ltd v. The Mongolian Government [2005] EWCA Civ. 395

Meritz Fire & Marine Insurance Co Ltd v Jan de Nul NV [2011] EWCA Civ 827 (21 July 2011); (29 July 2011);

Rainy Sky SA v Kookmin Bank [2011] UKSC 50; [2012] 1 All E.R. (Comm);

Simon Carves Ltd v Ensus UK Ltd [2011] EWHC 657 (23 March 2011);?

Vossloh Aktiengesellschaft v. Alpha Trains (UK) Ltd [2010] EWHC 2443 (5 October 2010);?

Wuhan Guoyu Logistics Group Co Ltd, Yangzhou Guoyu Shipbuilding Co Ltd v Emporiki Bank of Greece SA [2012] EWCA Civ 1629 (7 December 2012)

I (B) Legislations

Uniform Rules for Demand Guarantee, version 458.

Uniform Rules for Demand Guarantee, version 758.?

II – Secondary sources

II (A) Articles

Agasha Mugasha, ‘Enjoying the Beneficiary’s Claim on a Letter of Credit or Bank Guarantee’, Journal of Business Law, 2004, 515.?

Ebenezer Adodo, ‘Considerations of Business Common Sense in Advance Payment Bond/Demand Guarantee Interpretation: Rainy Sky SA v. Kookmin Bank’, in Journal of Business Law, issue 6, 2012, pp. 513-544.?

Christopher Wong, ‘Recent Developments on Demand Bonds and Guarantees in England and Australia’, in International Construction Law Review, vol. 29, part 1, 2012, pp. 51-71.?

Kirstin Bardel, ‘Consistency on-demand or guarantee?’, in Construction Law, vol. 24, issue 2, 2013, pp. 14-19.

Michael Furmston, ‘Guarantees and Bonds – distinguishing performance bonds from contracts of suretyship’, in Finance & Credit Law, November 2011, 1-5.?

Thanuja Rodrigo, ‘Mitigating the risk of unfair calling on-demand guarantee in the Sri Lankan Market’, in Journal of Business Law, 2011.?

Rhiannon Sigleton, ‘Performance bond and guarantees: what is needed to rebut the Marubeni presumption?’, in Butterworths Journal of International Banking & Financial Law’, 26 (4), 226, 2011.

Richard Pike, ‘Security of performance – bonds and guarantees, in Construction Newsletter, available at < www.westlaw.co.uk?

> 2 May 2013.

Richard Ward and Ben Bruton, ‘Calls on Performance bonds: avoiding pitfalls’, In-House Lawyer, May 2012, pp. 13-17.??

Sanjay Pantel, ‘Check the meaning’, in Maritime Risk International, 26 (7), 2012, pp. 16-18.?

II (C) Books:

Agasha Mugasha,?The Law of Letters of Credit and Bank Guarantees, The Federation Press, Sidney, Australia, 2003.

Agasha Mugasha,?The Law of Multi-bank Financing: syndicated loans and the secondary market, Oxford University Press, Oxford, 2007.?

Alastair Hudson,?The Law of Financial Derivatives, Sweet & Maxwell, London, 2012.?

Charles Hewetson and Nicholas Elliott QC,?Banking Litigation, 3rd Ed., Sweet & Maxwell, 2011.?

Deborah Horowitz,?Letters of Credit and Demand Guarantees: Defences to Payment,?Oxford University Press, Oxford, 2010.

E.P. Ellinger, E. Lomnicka and C.V.M. Hare,?Ellinger’s Modern Banking Law, 5th Ed., Oxford University Press, Oxford, 2011.

James O’Donovan and John Phillips,?The Modern Contract of Guarantee, Sweet & Maxwell Limited, London, 2003.

John F Dolan,?The Law of Letter of Credit: Commercial and Standby Credit, Pratt & Sons Group, Arlington, 1999.?

Jack Documentary Credit, Ali Malek QC and David Quest (ed.), 4th Ed., Tottel Publishing, 2009.?

Joanna Benjamin,?Financial Law, Oxford University Press, Oxford, 2007.

Matti S. Kurkela,?Letters of Credit and Bank Guarantees under International Trade Law, 2nd Ed., Oxford University Press, Oxford, 2007.?

Michael Brindle, Richard Coleman and David Waksman, ‘Documentary Credits and Related Transactions’, in Law of Bank Payments, (ed. Michael Brindle and Raymond Cox), Sweet & Maxwell, 1996.?

Paget’s Law of Banking, Mark Hapgood QC (ed.), 13th Ed., LexisNexis Butterworths, 2007.

Peter Ellinger and Dora Neo,?The Law and Practice of Documentary Letter of Credit, Hart Publishing, Portland, 2010.?

Phillip Wood,?Law and Practice of International Finance, Sweet & Maxwell, London, 2008.?

Roeland F. Bertrams,?Bank Guarantees in International Trade, 3rd Ed., Kluwer Law International, The Hague, 2004.?

William Hedley and Richard Hedley,?Bills of Exchange and Bankers Documentary Credits, 4th Ed., LLP Professional Publishing, 2001.